ICOs Avoiding US Citizens Not Immune To Lawsuits In USbr>
Last summer, the Securities and Exchange Commission (SEC) issued its 21(a) report concluding that, according to the Supreme Court’s decision in SEC v. W.J. Howey Co., the DAO token qualified as a “security” under the federal securities laws and its offering had to either be registered with the SEC or subject to an exemption from registration. While many commentators have since focused on the implications of the Howey test on initial coin offerings (ICOs), equally important issues are emerging. As the SEC takes aim at foreign issuers of tokens that took pains to avoid sales to U.S. citizens, questions about the application of personal and subject matter jurisdiction are now taking shape.
SEC v. PlexCorps
A recent example of the SEC’s persistence in combating fraudulent ICOs can be seen in its enforcement action in the Eastern District of New York against PlexCorps and its founders, Dominic Lacroix and Sabrina Paradis-Royer. In SEC v. PlexCorps, the SEC alleges that the defendants violated the securities laws and misappropriated more than $15 million from investors through false and misleading statements regarding the Plexcoin ICO. These include claims that investors can expect returns ranging from 200 percent to more than 1,300 percent, that the company has teams of professionals employed globally to ensure that the investments performed, and that the identity of its executives were being held secret for privacy and competitive reasons. The defendants, notably, are residents of Canada, and developed and launched the Plexcoin ICO in Canada. Soon after the SEC filed its complaint, the defendants sought to dismiss the case for lack of personal and subject matter jurisdiction.
In support of their argument for lack of personal jurisdiction, the defendants argue that both individual defendants are Canadian residents and that Plexcoin was developed and launched in Canada. They further emphasize that U.S. participation was explicitly excluded – potential investors were asked to confirm (1) that they were not U.S. citizens, and (2) that they were not purchasing tokens on behalf of a U.S. citizen. In response, the SEC contends that its allegation that 1,500 transactions took place with investors located in the U.S. is alone sufficient to confer personal jurisdiction. The SEC also alleges the defendants purposefully targeted U.S. investors by using social media and websites viewable in the U.S. to advertise the Plexcoin ICO and by using U.S.-based payment processing services.
The defendants also seek dismissal pursuant to the Supreme Court’s decision in Morrison v. National Australia Bank, Ltd., arguing that the U.S. court lacks jurisdiction to hear the case. In Morrison, the Court addressed the extraterritorial reach of §10(b) of the Securities Exchange Act of 1934 and held that §10(b) applies only to (1) “transactions in securities listed on domestic exchanges,” and (2) “domestic transactions in other securities.” After Morrison, courts in the 2nd Circuit have held that under the first Morrison prong, registering and listing a security on a U.S. exchange cannot by itself justify extraterritorial reach. Rather, the transaction – the purchase or sale – must have been executed on a U.S. exchange. This is the case regardless of whether or not the issuer and investor are U.S. residents.
Regarding Morrison’s second prong, the 2nd Circuit has held the following test for determining a “domestic transaction”: A plaintiff must plead sufficient facts “suggesting that irrevocable liability was incurred or title transferred within the United States.” And “irrevocable liability” for a purchase or sale occurs, as with a contract, “when the parties become bound to effectuate the transaction.” Examples of potentially sufficient factual allegations include formation of the contracts, placement of purchase orders, passing of title or exchange of money in the U.S. Even so, the Morrison extraterritoriality analysis is necessarily fact-specific, and the 2nd Circuit has explicitly rejected any bright-line test. Indeed, the court has held that although a transaction at issue may qualify as a “domestic transaction,” a domestic transaction is not necessarily sufficient to warrant the court’s jurisdiction over the matter, particularly where transactions are “so predominately foreign as to be impermissibly extraterritorial.”
PlexCorps challenges the SEC’s claims based on Morrison’s second prong and argues that the SEC’s complaint fails to include sufficient allegations showing irrevocable liability occurred within the U.S. It argues that the only allegation that suggests a domestic transaction is that some investors purchased Plexcoin tokens using credit cards with U.S. billing addresses. In contrast, the defendants emphasize that Plexcoin was developed and issued from computers abroad and investors also purchased tokens using decentralized, non-dollar-based cryptocurrencies such as bitcoin and Ethereum.
The parties’ respective arguments demonstrate the inherently fact-specific nature of this inquiry, and how U.S. jurisdiction may be asserted over seemingly foreign transactions, parties and ICOs. Indeed, the SEC’s discovery-related filings also provide some insight into how it intends to prove these U.S. contacts and pursue enforcement actions involving foreign ICOs. For example, former and current employees may be asked for information relating to the creation and operations of any websites, databases or other platforms; the opening of accounts with various payment processing vendors; the tracking of individuals who visited the defendants’ websites; and any efforts made to avoid contacts with the U.S. The SEC will also likely seek information specifically relating to purchasers (e.g., billing addresses, places of business, residence, IP addresses, and blockchain addresses or wallets). After the defendants in SEC v. PlexCorps failed to adequately respond to the SEC’s discovery requests, the court permitted the SEC to file interrogatories that included requests for:
- Email addresses associated with Plexcoin, and individuals who had access to any accounts.
- Social media accounts associated with Plexcoin, and individuals who had access to those accounts.
- Usernames for messaging platforms such as Skype and WhatsApp, and individuals who had access to the accounts.
- Computers and electronic devices used in connection with Plexcoin.
- Electronic databases created by PlexCorps or a third party containing purchaser information.
PlexCorps’s motion to dismiss is now due in June 2018, and the defendants have yet to comply with the prior discovery orders. As a result, the court granted the SEC’s request for an order requiring Lacroix to appear “immediately” for a deposition on the issue of personal jurisdiction in New York.
Although the defendants, particularly Lacroix, who the SEC alleges is a recidivist securities law violator in Canada, seem unconcerned with currying favor with the court, their delinquency may simply reflect the staunchness of their position – that the court lacks personal jurisdiction. Regardless of PlexCorps’s litigation strategy, this case is an example of how simply shifting an ICO abroad and seemingly excluding U.S. investors from participation may still expose issuers to SEC enforcement efforts.
In re Tezos Securities Litigation
Looking at the increase in private class actions after the SEC issued its 21(a) report on the DAO, the SEC’s argument that Morrison does not foreclose its enforcement of foreign ICOs may have the same effect on the plaintiffs’ bar. In fact, in the Tezos class actions, certain class plaintiffs raised the issue in the context of appointing a lead plaintiff. Three out of the four plaintiff groups are U.S.-based, while plaintiff Trigon Trading Pty. Ltd. (Trigon) is an Australian entity. The U.S.-based plaintiffs argued that the defendants’ potential Morrison-defense against Trigon rendered it an inadequate lead plaintiff. The court ultimately did not appoint Trigon lead plaintiff. However, it also never addressed the parties’ Morrison-related arguments. Nonetheless, this case shows how the plaintiffs’ bar may seek to circumvent Morrison by arguing the transactions at issue are “domestic,” because the tokens were created and exist on a blockchain owned and operated by a U.S. corporation.
While the issue of whether a token is a “security” under the U.S. federal securities laws is a fundamental one for any issuer considering an ICO, a close second and soon to be hotly contested issue is that of personal jurisdiction over the defendants and the court’s jurisdiction to hear cases involving essentially foreign interests and parties. It would not be surprising to see divergent decisions by district courts across the country on these cases where these are close issues. At some point, they will reach the circuit courts for consideration, which will provide greater clarity on the rules of the road for issuers of foreign ICOs.
 Marc D. Powers is a partner in BakerHostetler LLP’s New York office and the former national leader of its securities litigation and regulatory enforcement practice team and former SEC enforcement division branch chief. Jonathan A. Forman is a counsel at BakerHostetler who represents companies and executives in connection with litigation, government investigations and regulatory examinations, and who advises regulated entities on their compliance programs. Tiffany A. Miao is a litigation associate at BakerHostetler.
2 328 U.S. 293 (1946).
3 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Rel. No. 81207 (July 25, 2017),https://www.sec.gov/litigation/investreport/34-81207.pdf.
4 Although the SEC named “PlexCorps” as a defendant, defense counsel explains that there is no such entity known as “PlexCorps.” SeeDefendants’ Letter Request for Pre-Motion Conference, SEC v. PlexCorps, No. 17-CV-7007, ECF 27 (E.D.N.Y. Dec. 21, 2007). For purposes of this article, the authors will refer to the defendants collectively as “PlexCorps.”
5 Complaint, SEC v. PlexCorps, No. 17-CV-7007, ECF 1 (E.D.N.Y. Dec. 1, 2017).
6 Defendants’ Letter Request for Pre-Motion Conference, SEC v. PlexCorps, No. 17-CV-7007, ECF 27 (E.D.N.Y. Dec. 21, 2007).
7 Plaintiff’s Response to Request for Pre-Motion Conference, SEC v. PlexCorps, No. 17-CV-7007, ECF 30 (E.D.N.Y. Jan 5, 2018).
8 561 U.S. 247 (2010).
9 Morrison, 561 U.S. at 267.
10 See, e.g., City of Pontiac Policemen’s & Fireman’s Ret. Sys. v. UBS AG, 752 F.3d 173 (2d Cir. 2014); In re Vivendi Universal, S.A. Sec. Litig., 765 F. Supp. 2d 512 (S.D.N.Y. 2011), aff’d, 838 F.3d 223 (2d Cir. 2016).
11 Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 68 (2d Cir. 2012).
12 Id. at 67.
13 Id. at 68.
14 Parkcentral Global Hub Ltd. v. Porsche Auto. Holdings SE, 763 F.3d 198, 216 (2d Cir. 2014).
15 See Plaintiff’s Memorandum of Law in Support of Its Motion for the Court to Issue a Letter Rogatory, SEC v. PlexCorps, No. 17-CV-7007, ECF. 34-3 (Feb. 23, 2018).
17 See Plaintiff’s Jurisdictional Interrogatories to Defendants, SEC v. PlexCorps, No. 17-CV-7007, ECF 47 (Apr. 25, 2018).
18 See Plaintiff’s Letter, SEC v. PlexCorps, No. 17-CV-7007, ECF. 55 (May 3, 2018); Order dated May 8, 2018; Notice dated May 15, 2018.
19 One potential divisive effect on this issue is how courts will interpret Section 929 of the Dodd-Frank Act.
20 GGCC, LLC v. Dynamic Ledger Solutions, Inc., No. 17-CV-6779; Okusko v. Dynamic Ledger Solutions, Inc., No. 17-CV-6829; see also MacDonald v. Dynamic Ledger Solutions, Inc., No. 17-CV-7095 (voluntarily dismissed); Baker v. Dynamic Ledger Solutions, Inc., No. 17-CV-6850 (remanded to state court).
21 Order, GGCC, LLC v. Dynamic Ledger Solutions, Inc., No. 17-CV-6779, ECF 101 (N.D. Cal. Mar. 16, 2018).
22 See, e.g., Trigon’s Opposition to Cross-Motions for Appointment as Lead Plaintiff, GGCC, LLC v. Dynamic Ledger Solutions, Inc., No. 17-CV-6779, 2018 WL 1093397 (N.D. Cal. Feb. 8, 2018).